December 17, 2012

Economist's View: Is the Fed Risking "Dangerous Side Effects"?: What does [Robert Samuelson] think a dual mandate means if not the "twin targeting of unemployment and inflation"? That's not unique to the 1970s…. [Samuelson] is trying to tell the story about shifting Phillips curve due to rising inflationary expectations, but he misses a key part of the story…. [T]he Fed was shooting at the wrong unemployment target (you can find this story in most textbooks, e.g. see Mishkin's text on demand-pull inflation). The Fed was shooting at a 4 percent unemployment target… the natural rate had drifted as high as 7 percent…. Unfortunately, the Fed didn't not realize this…. The fundamental problem… a miscalculation of the natural rate of unemployment… has the Fed made this mistake again? Is the natural rate of unemployment a lot higher than 6.5 percent?… First, the Fed is fully aware of this past mistake…. Second, there has been considerable effort to measure the structural/cyclical/frictional unemployment mix…. We didn't have this type of information in the 1970s…. Finally, there is an inflation threshold of 2.5 percent, a relatively low level of tolerance for mistakes of this type. If the Fed is wrong about the structural rate, we'll see inflation, and if it the projected inflation rate drifts above 2.5 percent, the program will be reversed. I have no doubt that the Fed is serious abut pulling the plug….

Samuelson… is good at playing the Very Serious Person role (inflation is coming!, the debt will cause interest rates to spike!, there could even be "dangerous side effects, including a future financial crisis"!), but the Fed is not risking a repeat of the 1970s, not even close.

Robert Samuelson:

The Fed rolls the dice…. It was big news last week when the Federal Reserve announced that it wants to maintain its current low-interest rate policy until unemployment, now 7.7 percent, drops to at least 6.5 percent…. [T]he Fed has tried this before and failed — with disastrous consequences…. By 1980, inflation was 13 percent and unemployment, 7 percent…. Today’s problem is similar…. It’s seductive to think the Fed can engineer the desired mix of unemployment and inflation…. But the Fed is bumping against the limits of its powers…

Comments

Economist's View: Is the Fed Risking "Dangerous Side Effects"?: What does [Robert Samuelson] think a dual mandate means if not the "twin targeting of unemployment and inflation"? That's not unique to the 1970s…. [Samuelson] is trying to tell the story about shifting Phillips curve due to rising inflationary expectations, but he misses a key part of the story…. [T]he Fed was shooting at the wrong unemployment target (you can find this story in most textbooks, e.g. see Mishkin's text on demand-pull inflation). The Fed was shooting at a 4 percent unemployment target… the natural rate had drifted as high as 7 percent…. Unfortunately, the Fed didn't not realize this…. The fundamental problem… a miscalculation of the natural rate of unemployment… has the Fed made this mistake again? Is the natural rate of unemployment a lot higher than 6.5 percent?… First, the Fed is fully aware of this past mistake…. Second, there has been considerable effort to measure the structural/cyclical/frictional unemployment mix…. We didn't have this type of information in the 1970s…. Finally, there is an inflation threshold of 2.5 percent, a relatively low level of tolerance for mistakes of this type. If the Fed is wrong about the structural rate, we'll see inflation, and if it the projected inflation rate drifts above 2.5 percent, the program will be reversed. I have no doubt that the Fed is serious abut pulling the plug….

Samuelson… is good at playing the Very Serious Person role (inflation is coming!, the debt will cause interest rates to spike!, there could even be "dangerous side effects, including a future financial crisis"!), but the Fed is not risking a repeat of the 1970s, not even close.